Complacency Risk Is High

As I was writing this past weekend's newsletter "A Technical Review Of The Markets" it really dawned on me just how complacent investors have become on the economy, the markets and risk in general. The mainstream media, and most of analysts, are looking at recent improvements in the economic data as a sign that the economy has begun to make a turn for the better. This view is further supported by the rise of the stock market.

With a couple of breadcrumbs, a sprinkle of "hope" and a cup of optimism - analysts, economists and investors have whipped up the perfect concoction by extrapolating recent upticks into long term future advances. However, this is a game that we have seen play out repeatedly before.

Take a look at the chart of the volatility index versus the S&P 500. The media and analyst community were convinced early on in 2007, even though we did protest heavily, that the economy would experience a "Goldilocks scenario" and the economy would "muddle through." As the market declined, and one indication after another showed that the coming crisis would be far worse than people imagined, investors remained complacent until the "Oh $#@!" moment occurred. Unfortunately, by that time it was far too late. The same thing occurred in 2009 as the Fed intervened with quantitative easing and then again in 2010 with Q.E. 2. Each time, as the volatility index retraced back to levels of complacency, the seeds were sown for the next "Oh $#@!" moment.

Reminiscent of the "Perfect Storm" where the Captain of the Andrea Gail gets a brief reprieve from danger as the eye of the storm passed by - investors today are currently basking in warmth of rally not realizing that much more danger lies ahead. Bullish sentiment, as measured by the composite of AAII and Investors Intelligence indexes, is currently at very bullish levels. While this does not mean that a market correction of some magnitude is imminent - it does mean that most likely further gains are likely to be small and the next correction is likely not too far away.

David Rosenberg agreed with this veiw point in today's missive:

"Most measures of market sentiment are back to where they were last May just when the S&P 500 was peaking.

Short interest has dried up to three year lows.

The VIX closed the week below 20 for the first time since last July.

As Mike Santoli points out in Barron's, volume in leveraged ETF's versus bearish ones has risen to levels that in the past touched off interim market pullbacks.

Credit market indicators have lagged well behind the improvement in equity performance.

The S&P 500 is three standard deviation points above its 20-day moving average.

Again, as Barron's points out, the ratio of the 15-day volume puts on the S&P 100 Index to bullish call volume hit 2-to-1 last week - this happened in the February 2007, February 2011 and April 2011."

As I said in this past weekend's newsletter if you look at the markets, commodities, bonds and the dollar there is really not much that is screaming "BUY ME" at the current time. The markets are very overbought on a short term basis and further gains are likely to be limited.

This is not a prediction of the next bear market cycle or the next recession. Those are coming, either sooner or later, as they are a function of the economic and business cycle. The current trend of the market is bullish and the majority of our "buy signals" are aligned. However, the level of complacency that has surrounded this recent rally is getting to dangerous levels and it is only a function of time before the next "Oh $#@!" moment arrives.

As Mike Santoli pointed out in his piece in Barron's: "Each instance foretold an imminent correction of some significance...the notion that equities have gotten slightly ahead of themselves is as valid now as it was a year ago." Trade accordingly.

Lance Roberts is the General Partner and Chief Portfolio Strategist for STA Wealth Management. He is also the host of "Street Talk with Lance Roberts", Chief Editor of "The X-Factor" Investment Newsletter and the Streettalklive daily blog. Follow Lance on Facebook, Twitter and Linked-In